Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

Thursday, February 2, 2017

Marty McFly and Future Interests In A Trust

Let’s talk about gift taxes.

Someone: What is an annual gift tax exclusion?

Me: The tax law allows you to gift any person on the
planet up to $14,000 a year for any reason without having to report the gift to
the IRS. If you are married, your spouse can do the same – meaning you can team-up
and gift up to $28,000 to anybody.

Someone: What if you go over $14,000 per person?

Me: It is not as bad as it used to be. The reason starts
with the estate tax, meaning that you die with “too many” assets. This used to
be more of an issue a few years back, but the exclusion is now north of $5.4
million. There are very few who die with more than $5.4 million, so the estate
tax is not likely to impact ordinary people.

Someone: What does the gift tax have to do with this $5
million?

Me: Congress and the IRS saw gifting as the flip side
of the coin to the estate tax, so the two are combined when calculating the
$5.4 million. Standard tax planning is to gift assets while alive. You may as
well (if you can) because you are otherwise going to be taxed at death. Gifting
while alive at least saves you tax on any further appreciation of the asset.

Someone: Meaning what?

Me: You will not owe tax until your gifts while alive plus
your assets at death exceed $5.4 million.

Someone losing interest: What are we talking about
again?

Me: Riddle me this, Batman: you transfer a gaztrillion
dollars to your irrevocable trust. It has 100 beneficiaries. Do you get to
automatically exclude $1,400,000 ($14,000 times 100 beneficiaries) as your
annual gift tax exclusion?

Someone yawning: Why are we talking about this?

Me: Well, because it landed on my desk.

Someone: Do you make friends easily?

Me: Look at what I do for a living. I should post
warnings so that others do not follow.

Someone looking around: How about hobbies? Do you need
to go home to watch a game or anything?

Me: There is a tax concept that becomes important when
gifting to a trust. A transfer has to be a “present interest” to qualify for
that $14,000 annual exclusion.

Someone resigned: And a “present interest” is?

Me: Think cash. You can take it, frame it, spend it,
make it rain. You can fold it into a big wad, wrap a hundred-dollar bill around
it and pull the wad out every occasion you can.

Someone: What is wrong with you?

Me: Maybe it’s just me that would do that.

Me: I tell you what a “present interest” is not: cash
in a trust that can only be paid to you when some big, bad, mean trustee
decides to pay. You cannot party this weekend with that. You may get cash, but
only someday … and in the future.

Someone: Hence the “future?”

Me: Exactly, Marty McFly.

Someone surprised: Hey, there’s no need ….

Me: Have you ever heard of a Crummey power?

Someone scowling: Good name for it. Fits the
conversation.

Me: That is the key to getting a gift to a trust to
qualify as a present interest.

Someone humoring: What makes it crummy?

Me: Crummey. That’s the name of the guy who took the
case to court. Like a disease, the technique got named after him.

Someone looking at watch: I would consider a disease
right about now.

Me: The idea is that you give the trust beneficiary the
right to withdraw the gift, or at least as much of the gift as qualifies for
the annual exclusion. You also put a time limit on it – usually 30 days. That
means – at least hypothetically – that the beneficiary can get his/her hands on
the $14 grand, making it a present interest.

Someone: I stopped being interested ….

Me: Have you heard of a “in terrorem” provision?

Someone: Sounds terrifying.

Me: Yea, it’s a great name, isn’t it? The idea is that
– if you behave like a jerk – the trustee can just cut you out. Hence the
“terror.”

Someone: I cannot see a movie coming out of this.

Me: Let’s wait and see what Ben Affleck can do with it.

Me: I was looking at a case called Mikel, where the IRS said that the “in terrorem” provision was so
strong that it overpowered the Crummey power. That meant that there was no
present interest.

Someone: Can you speed this up?

Me: The transfer to the trust was over $3.2 million ….

Someone: I wish I could meet these people.

Me: The trust also had around 60 beneficiaries.

Someone: 60 kids? Who is this guy – Mick Jagger?

Me: Nah, his name is Mikel.

Someone: I was being sarcastic.

Me: Mikel was Jewish, and he put a provision in the
trust that beneficiary challenges to a trustee’s decision would go to a panel
of 3 persons of Orthodox Jewish faith, called a beth din.

Me: I suppose if the beth din sides with the trustees,
the beneficiary could go to state court, but then the in terorrem provision
would kick-in. The beneficiary would lose all rights to the trust.

Someone: So some rich person gets cut-off at the knees.
Who cares?

Me: The IRS said that the in terrorem provision was
strong enough to make the gift a future interest rather than a present
interest. That meant there was no $14,000 annual exclusion per beneficiary.
Remember that there were around 60 beneficiaries, so the IRS was after taxes on
about $800 grand. Not a bad payday for the tax man.

Someone: Sounds like they can afford it.

Me: No, no. The Court disagreed with the IRS. The
taxpayer won.

Someone backing away: What was the court’s hesitation?

Me: The Court felt the IRS was making too many
assumptions. If the beneficiaries disagreed with the trustees, they could go to
the beth din. The beth din did not trigger the in terrorem. The beneficiaries
would have to go to court to trigger the in terrorem. The Court said there was
no reason to believe the beth din would not decide appropriately, so it was
unwilling to assume that the beneficiaries were automatically bound for state
court, thereby triggering the in terrorem provision.

About Me

Thirty years years in tax practice. It's a long time, and I have seen virtually everything short of the fabled tax-exempt unicorn. I was raised in Tampa, went to school in Missouri, taught at Eastern Kentucky University, lived in Georgia, got pulled to Cincinnati when I married, have in-laws in England and a daughter going to the University of Tennessee. I am not sure where I will wind up next, but I hope there is better weather.